Morgan Stanley finds a way to trade the US dollar based on the market’s obscure accuracy on inflation

For much of the past few years, an obscure corner of the financial market has done a better job than professional forecasters of predicting where the headline annual inflation rate from the US Consumer Price Index report will land.

Now strategists at Morgan Stanley MS,
+0.19%
have found a way to negotiate on this clarification. They offer to take a position in the US dollar on the days the data is released, based on the direction in which the derivative instruments, known as CPI fixings, are pointing the day before.

Lily: “Inflation is going to be more rigid than most people imagine”: inside the dark market where traders were mostly right on price gains.

Inflation has been the biggest wild card impacting traders and investors over the past year, outpacing virtually everyone, although fixing traders have been closest to the actual mark. June’s headline CPI rate of 9.1% YoY, however, beat the expectations of both fixation traders and forecasters, and since then there have been growing hopes that inflation has peaked.

“Investors have been overly optimistic that the Fed’s rate hike will have the desired impact of moderating price increases,” said Lindsey Piegza, chief economist at Stifel Nicolaus & Co. in Chicago. “But a lot of the inflationary pressures we see are beyond the Fed’s control, and investors are underestimating those external factors that the Fed can’t influence with traditional monetary policy tools.”

“Even at an inflation rate of 9.1%, I’m still not convinced that we’ve seen peak levels and we could see additional price pressures coming in,” Piegza said by phone.

The chart below shows how far the fixings have anticipated the direction of inflation, compared to the median expectation of forecasts from a Bloomberg survey and actual CPI prints.

Source: Bloomberg, Morgan Stanley Research

In a note on Friday, Morgan Stanley’s Matthew Hornbach, Andrew Watrous and Francesco Greci wrote that the dollar “typically gains when the CPI surprises on the upside (and vice versa) and the CPI fixing market provides a semi-reliable indicator of future CPI prints”. .”

They proposed a strategy of taking a long position in the US dollar if – one day before the CPI report – the CPI fixing is above the Bloomberg survey’s median forecast, and taking a position short when fixing is below the survey median. The position would be opened at 8 a.m. Eastern Time on the day of the CPI report, or 30 minutes before the data is released. The strategy has the potential to outperform if the position is held until 5 p.m. on the same day, they wrote.

On Monday morning, the ICE US Dollar Index DXY,
-0.20%
fell 0.2% to 106.50, but remained near 20-year highs, while shares of DJIA,
+0.29%

SPX,
+0.19%

COMP,
-0.34%
traded mixed ahead of Wednesday’s Fed rate decision.

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